Wednesday, April 14, 2010

How loan servicers milk the foreclosure-prevention program

If there’s one consistent villain in the tale of attempts to minimize home foreclosures, it’s the loan servicers. They lose paperwork, they foreclose on homes they have no right to foreclose on, they accept borrowers into modification programs while trying to foreclose on them at the same time, they deny borrowers a modification even when they shouldn’t, they’re impossible to get ahold of, their communication with borrowers is atrocious, they claim to be owed vastly more money than they actually are owed, and so on and so forth.

Which is why it’s so depressing that servicers are actually the biggest winners of the way that the government is doing mortgage modifications — at the expense of homeowners, no less. Shahien Nasiripour, who is not giving up in his attempt to push principal reduction as a solution to the mortgage-modification problem, finds this in the latest COP report:

“HAMP’s original emphasis on interest rate reduction, rather than principal reduction, benefits lenders and servicers at the expense of homeowners,” the report reads. “Lenders benefit from avoiding having to write down assets on their balance sheets and from special regulatory capital adequacy treatment for HAMP modifications. Mortgage servicers benefit because a reduction in monthly payments due to an interest rate reduction reduces the servicers’ income far less than an equivalent reduction in monthly payment due to a principal reduction.

“Servicers are thus far keener to reduce interest rates than principal. The structure of HAMP modifications favors lenders and servicers, but it comes at the expense of a higher redefault risk for the modifications, a risk that is borne first and foremost by the homeowner but is also felt by taxpayers funding HAMP.”

Servicers’ primary compensation is a percentage of the outstanding principal balance on a mortgage. Thus, principal reductions reduce servicers’ income, whereas interest reductions do not, and forbearance and term extensions actually increase servicers’ income because there is greater principal balance outstanding for a longer period of time.

It’s worth noting here that another set of losers in this set-up is the people who bought mortgage-backed securities. Banks benefit from this system because they don’t need to write down their mortgages, and because they often own servicers. But investors in mortgages mark to market: they have no choice when it comes to taking losses. And when a servicer keeps the principal amount high and the interest amount low, that just means that the owner of the mortgage pays unnecessary extra money to the loan servicer.

That’s true of private mortgage investors at mutual funds and hedge funds — but it’s also true of the biggest mortgage investors of them all, Fannie Mae and Freddie Mac. Is it too much to hope that they might start pressuring the government to force more principal reductions?